CASE 1/95

Members:
BJ McMahon DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 12 December 1994

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BJ McMahon (Deputy President)

The applicant, a company, formerly carried on a business of manufacturing conveyor belts in a division under a business name. In April 1978 the applicant entered into a contract with ``coal company'' for the supply of a conveyor belt to be installed in a colliery operated by ``coal company''. In June 1978 the applicant entered into a contract with ``rubber company'' to supply, as a subcontractor to the applicant, rubber conveyor belting for the conveyor belt to be installed by the applicant at the colliery.

2. The conveyor system was installed and commissioned on or about April 1979. On 10 July 1981 the applicant sold all of the assets of the business of the division, except some uncompleted contracts, to a new company two thirds of the issued share capital of which was then owned by the applicant and one third by a public company. The assets of the division sold to the new company were separately identified in the accounts and records of the applicant as being the assets of the division and included the whole of its real estate where it carried on its business, but excluded a number of commercial contracts which were uncompleted. The applicant remained liable to complete the commercial contracts at its own risk and cost.

3. Under the arrangements, it was agreed that the public company would buy the applicant's shares in the new company in 2 equal instalments, the first payable on 31 December 1982 and the second on 30 June 1984, and that the applicant would share the management and control of the new company until 30 June 1984.

4. The principal reason for the instalment sale of the business and the continued involvement of the applicant in the ownership and management of the new company during the 3 years ending 30 June 1984, was because the applicant had to engage the new company as a subcontractor to complete the outstanding contracts. All of these were completed on or before 30 June 1984.

5. Under the contractual arrangements with the new company and the public company, the applicant continued to be liable for the cost of any claims arising from the prior conduct of the business by the applicant before its sale to the new company.

6. The coal company claimed that the conveyor system was defective in certain respects and commenced legal proceedings against the applicant in the New South Wales Supreme Court on 17 August 1981, although the actual process was not served on the applicant until 13 September 1982.

7. After 30 June 1984, the business activities of the applicant consisted of unrelated manufacturing activities carried on by other divisions. These manufacturing activities were sold in 1985 and 1987. After 31 December 1987, the activities of the applicant consisted exclusively of investment in, and management of, related corporations.

8. During the year of income ended 31 December 1989 (the applicant had a substituted accounting period) the applicant paid the sum of $325,000 to ``coal company'' in settlement of the legal dispute and also incurred legal fees of $58,379 in relation to that dispute. It claimed a deduction for both amounts in its return of income for the year ended 31 December 1989. The claims were disallowed, principally

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because the payments were made after the applicant had sold its conveyor belt manufacturing business and had ceased to carry on that kind of business. This application is brought to review the objection decision.

9. The respondent relies principally upon the principles established in
Amalgamated Zinc (De Bavay's) Limited v FC of T (1935) 3 ATD 288; (1935) 54 CLR 295 (``De Bavay''). In that case a company for many years carried on the business of producing zinc concentrates and other metalliferous substances at Broken Hill. During the 1924 year the company discontinued this business and later disposed of its plant and equipment in 1929. On and from 31 December 1920 the company was liable pursuant to the Workmen's Compensation (Broken Hill) Act 1920 to pay money annually to a compensation fund established under that Act. The fund was set up to pay compensation to employees of mine owners at Broken Hill (including the company) who contracted tuberculosis due to their work. Although the company had discontinued its business, it remained liable to make, and did in fact make, payments to the compensation fund in the 1932 and 1933 years of income and claimed a deduction for those amounts. During the 1932 and 1933 years of income, the only income of the company consisted of income by way of dividends and interest. The issue that arose for the consideration of the High Court was whether the compensation payments made by the company for the 1932 and 1933 years were allowable deductions.

10. Five judges of the High Court delivered judgments unanimously rejecting the company's claims. All of the judgments are surprisingly brief, but nevertheless, clear. The leading judgments were written by Latham CJ and by Dixon J.

11. The court considered the effect of s 26(1)(a) of the Income Tax Assessment Act 1922, the forerunner of the first limb of s 51 of the present Act. The terms of those 2 provisions are sufficiently close to allow one to regard observations made about the earlier section to have application to the later provision. Certainly this has been accepted in many cases since De Bavay was decided.

12. The court rejected the notion that income corresponding to the outlaid expenditure must occur within the same accounting period. It found however that a nexus must exist between the outgoing and the income earned. In that particular case, the notion of a continuing business was introduced in order to provide the nexus. At ATD pages 293-294; CLR page 303 Latham CJ said-

``In this case, however, the outgoings in question have no relation whatever to the assessable income of the years in question. It is true that, in cases of continuing businesses, it has been conceded (perhaps upon a not very strict construction of this or a similar legislative provision) that expenditure may be allowed as a deduction though it produces and is possibly designed to produce results in the way of income in a future year and not in the year in relation to which income is being assessed (
Ward & Co v Commissioner of Taxes [1923] AC 145). So it has also been held that expenditure which has a direct relation to income of a past year can be deducted in a later assessment year where it is of such a character that, in a continuing business, it must be met from time to time as a part of the process of gaining assessable income (
Herald and Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113). But even this benevolent interpretation cannot assist the taxpayer in a case like this, where there has been a complete cessation of the income-producing operations out of which the necessity to make the outgoing arose.''

13. Dixon J elaborated upon the concept at ATD pages 297-298; CLR page 309-

``In a continuing business, items of expenditure are commonly treated as belonging to the accounting period in which they are met. It is not the practice to institute an inquiry into the exact time at which it is hoped that expenditure made within the accounting period will have an effect upon the production of assessable income and to refuse to allow it as a deduction if that time is found to lie beyond the period. And, in the case of expenditure for which the taxpayer contracted a liability during an earlier accounting period than that in which it has matured, it is not the practice to consider whether its effect upon the production of income of a still continuing undertaking has already been exhausted. The terms of sec. 23(1)(a) have never been understood as requiring such a thing (see
Ward & Co v

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Commissioner of Taxes (1923) AC at p 148 VOL LIV and
Herald and Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR at p 118). The expression `in gaining or producing' has the force of `in the course of gaining or producing' and looks rather to the scope of the operations or activities and the relevance thereto of the expenditure than to purpose in itself. Purpose in itself may be the criterion expressed by the word `for' which occurs in the correlative prohibition contained in sec. 25(e). This provision, however, does not prefix the definite article to the words `assessable income' and, therefore, is satisfied if the purpose is the production of income considered independently of division into periods of account. The practice which prevails in the case of continuing businesses is, therefore, not inconsistent with the interpretation of sec. 23(1)(a) which makes it refer to the assessable income from which the deduction is to be made.''

14. This decision has now been in place for 60 years and has been applied on numerous occasions. The respondent relied upon it in the present proceedings, submitting that the applicant did not satisfy the continuing business requirement, as the business in respect of which the deductions related, ceased on 30 June 1984 (at the latest). Although the possibility was raised in the applicant's statement of facts and contentions that in fact the business had continued until all outstanding obligations had been met, that argument was not pursued at the hearing before me.

15. An old and widely applied decision of a Full Bench of the High Court is obviously binding upon this Tribunal. The applicant sought to show that the concepts inherent in the judgments in De Bavay have been modified by later decisions, and in particular by the majority decision in
AGC (Advances) Limited v FC of T 75 ATC 4057. It was submitted that in that case, Barwick CJ and Mason J had rejected ``the continuing business'' test although it was conceded that Gibbs J, in the minority, fully endorsed it. In my view, this is not a correct reading of the AGC decision.

16. In that case the taxpayer, up until December 1968, carried on business as a financier lending money and financing the purchase of goods under hire purchase agreements. In 1969 under a scheme of compromise and arrangement a special manager was appointed to act as agent of the company and to take possession of its assets and wind up its affairs. In June 1970 it recommenced business in financing hire purchase transactions, although from a new address, under a new name and with new shareholders and new clients. For the years of income ended 30 June 1970 and 1971 the taxpayer claimed a deduction under s 51(1) for bad debts arising in respect of the business carried on prior to December 1968.

17. Whilst certain observations were made principally by Barwick CJ, it seems clear to me that far from overruling De Bavay, the majority in fact followed that case by basing their finding on the fact that notwithstanding the suspension of business, continuity of business had been established. Barwick CJ said at page 4064-

``In Amalgamated Zinc (De Bavay's) Limited v F.C. of T. (supra), the expression `a continuing business' was used to qualify the occasion when an expenditure not precisely related to the assessable income of a particular year was an allowable deduction. The description was intended, in my opinion, to convey the notion that in the case of an expenditure, the business of the taxpayer in respect of which the expenditure was made would probably in due course reflect in its income the proceeds or effects of that expenditure, or that it would already have done so where the expenditure was discharging an outstanding liability. I do not regard the expression `continuing' in such a temporal sense that if there were any break in the carrying on of the business for some reason, the business could not be regarded relevantly as continuous.''

18. This observation, it seems to me, does not deny validity to the tests applied in De Bavay but merely clarifies the understanding which the court should have of the expression ``continuing''.

19. His Honour went on to affirm that continuity of business could consistently exist with a break in the carrying on of that business-

``However that may be, I do not regard that case as deciding that, even in the case of expenditure, the business in respect of which the expenditure is made must be or has already been carried on without any

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substantial break. It seems to me that the most that could be deduced from the construction of the section applied in Amalgamated Zinc (De Bavay's) Limited v. F.C. of T. (supra) in relation to an expenditure is that where there has been a break in the carrying on of the business yielding the assessable income of the particular year that business must in its nature be substantially the same as that which was carried on at the earlier period of time.''

20. Nevertheless, His Honour conceded that if the break was substantial, it might be necessary to say that the relationship between expenditure and income had ceased to be sufficiently proximate-

``It is clear enough, it seems to me, that in order to be a relevant loss it must be a loss of money which has been put out in order to gain assessable income. It may be, and I have no need to decide that question at the moment, that if a long period of years separated the two events and meantime the company had started a different business or become an investment company as in Amalgamated Zinc (De Bavay's) Limited v. F.C. of T. (supra), it may be necessary if that decision is followed in such a case to say that the relationship between the two had ceased to be sufficiently proximate. It would suffice for my present purpose that I am not satisfied that, in order to be deductible, the loss which flows from carrying on a business carried on to gain assessable income need necessarily occur in a year when the company is actively carrying on that business.''

21. These observations, of course, are obiter. As Professor Parsons pointed out (Income Taxation in Australia paragraph 5.40) the majority opinions in AGC accepted the contemporaneity requirement laid down in De Bavay ``albeit with some reluctance''. Any obiter comment by a Chief Justice of the High Court must be given considerable weight by this Tribunal. However, it seems to me that nothing that His Honour said is inconsistent with the way in which the De Bavay concepts have been treated in subsequent cases.

22. In his discussion of De Bavay, Barwick CJ (at page 4065 column 2) suggested that the earlier case had nothing to say as to the deduction of losses as distinct from outgoings. In my view, the present applicant can draw no comfort from this observation, even if weight were given to these obiter comments, as the amounts paid to settle the Supreme Court action and legal costs were clearly outgoings and not losses. Professor Parsons discusses the difference between those 2 concepts at paragraphs 5.14 to 5.22. Whilst the 2 terms have sometimes been quoted as if they were interchangeable, the fact that Barwick CJ perceived a difference in the treatment of the 2 concepts indicates that there is clearly a difference between them.

23. The applicant contended that a loss is distinguishable from an outgoing by its involuntary nature. This is one of the many attempts made to come to an understanding of the difference between the 2 concepts. If it is correct, however, I would still be unable to accept the payments made to the coal company and to the applicant's lawyers as involuntary. They were payments freely made and after a negotiated settlement. They were not payments found by a third party, such as a court, to be payable by the applicant. An outgoing is the opposite of income and connotes a movement of resources out of the taxpayer's control or dominion. A payment of money is clearly an outgoing and this is what happened in the present case.

24. There are several Federal Court decisions and decisions of Boards of Review and of this Tribunal that have confirmed and applied the principles established in De Bavay. A Full Court of the Federal Court in
Inglis v FC of T 80 ATC 4001, held that the relevant claim for a deduction did not satisfy the second limb of sub-section 51(1) as there was no longer a business being carried on and, given the time that had elapsed since the business had ceased (4 to 5 years), the outgoing was too remote to be deductible under the first limb. At page 4011 column 1 Davies J acknowledged the effect of De Bavay, but considered that the relationship between expenditure and derivation of income in that particular case was too tenuous to justify the invocation of the De Bavay principles.

25. In
Freeman v FC of T 83 ATC 4456 the taxpayer company paid a lump sum retiring allowance to its former directors 2 years after the company had ceased business operations. A deduction for the lump sum payments pursuant to sub-section 51(1) was denied by another Full Federal Court on the authority of De Bavay.

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Franki J at page 4466 column 1, simply applied those principles without question. Northrop and Fisher JJ at page 4475 column 1 also endorsed the continuing business test.

26. A third Full Court decision
FC of T v Riverside Road Pty Limited (In Liquidation) 90 ATC 4567 may have modified the absolute application of the De Bavay principles to some extent. At page 4575 their Honours suggested that some of the observations in AGC supported some qualification to the absolute principles suggested in De Bavay. Their observations, however, support a qualification only to the extent where there has been a cessation of business shortly prior to the relevant outgoing. On the facts in Riverside Road, shortly means months, not years. The outgoings considered in that case continued only for a period of 3 months after the taxpayer changed the activities of its business. The present applicant can draw no comfort from Riverside Road, however, as its business had ceased completely some years prior to the relevant outgoing.

27. In addition to these Federal Court decisions, there have been a number of decisions of either a Board of Review or of this Tribunal in which the De Bavay principles have been followed. In Case R65,
84 ATC 468 the taxpayer borrowed money to purchase a cake shop business which proved to be unsuccessful. The taxpayer was denied a deduction for a claim for interest outgoings incurred on the loan after termination of the business. In Case S30,
85 ATC 280 the taxpayer borrowed money to buy a grocery business. The business was ultimately closed down and the taxpayer continued to pay interest under the loan agreement and the rental and rates on the premises. The deductions were denied.

28. All the cases since AGC were carefully reviewed by Deputy President Nicholson (as he then was) in Case U177,
87 ATC 1020. In that case (where the facts bear some resemblance to the facts in the present application) the taxpayer as an employer had ceased carrying on a business and was paying off by instalments a judgment debt it was liable to pay in respect of an industrial accident that arose when it was carrying on its business. The claim was disallowed on the basis that the earlier termination of the business meant that the second limb of sub-section 51(1) had no application and the first limb was not operative in the circumstances, as there was not a sufficient nexus with the earlier income producing activities due to the period of time that had elapsed. Having reviewed the application of De Bavay in various subsequent cases, Deputy President Nicholson concluded-

``From this review of the decisions in which Amalgamated Zinc (supra) has been cited, it appears to this Tribunal that:

• (i) an expenditure or an outgoing which may be incidental to, and relevant to, the gaining or producing of assessable income in an earlier year(s) is not precluded simply because of that fact from being an allowable deduction from assessable income under sec. 51(1) in arriving at the taxable income(s) of a later year or years;
• (ii) allowing therefore that sec. 51(1) enables deduction of expenditure incurred in gaining or producing assessable income with or `without regard to division into accounting periods' - A.G.C. (Advances) (supra) per Mason J. at ATC p. 4071; C.L.R. p. 197 - it is still necessary for the taxpayer to establish the relevant nexus in terms of that section between derivation and outgoings;
• (iii) where a cessation of business has occurred:
  • (a) it is first necessary to ascertain whether there has been truly a cessation of business or whether the business could still be considered to be carried on after the cessation of activity;
  • (b) where the business has truly ceased, the second limb of sec. 51(1) has no application;
  • (c) whether the first limb of sec. 51(1) then applies requires an examination of all the circumstances of the matter to determine the degree of proximity between the claimed expenditures and the earlier operation of the business and whether as a question of fact there is the connection made necessary by sec. 51(1) pursuant to which the deduction is sought. The question is whether the discontinuity of business has alone broken the nexus between derivation and

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    outgoing or whether that nexus, in the context of particular facts, endures;
  • (d) where the business has ceased in circumstances on all fours with the circumstances in Amalgamated Zinc (supra), that decision will be authority precluding the deduction in relation to the first limb of sec. 51(1).''

29. With respect, I agree with these conclusions. It was argued on behalf of the present applicant that, at the very least, sub- paragraph (iii)(b) above could not be supported by AGC. Whether this is so or not, it is clearly supported by the observations of Davies J in Inglis at page 4010 column 2.

30. In the face of this overwhelming authority, the applicant relied upon an early case reported as Case 127
4 CTBR (NS) 760. That case seems to be inconsistent with the later decision of the High Court in
Avondale Motors (Parts) Pty Limited v FC of T 71 ATC 4101 and is certainly contrary to the weight of authority to which I have earlier referred. This Tribunal continues to follow the later decisions. A recent example is Case X3,
90 ATC 114.

31. The basic proposition in De Bavay is that if a business ceases completely, the relevant nexus between the earning of the assessable income and incurring of deductions after the business ceases, is broken. Any suggestion that the relevant nexus may still endure after cessation of business has only been made in the context of a relative short break, or in the winding down of the business.

32. In the present case the claim arose in August 1981 out of the operations of the applicant's business in April 1979. The payment of the outgoings did not take place until 1989. This was at least 4 years after the applicant had ceased its business. On the authority of the cases to which I have referred, the relevant nexus does not exist between the outgoing and the income of the business, both because of the period of time that has elapsed since the business ceased, and the fact that the outgoings were not relevantly connected with the earlier operations of the applicant. The applicant suggested that some of the decisions to which I have referred (particularly Case U177) have misconstrued AGC. It was further submitted that rejection of the applicant's claim for a deduction would lead to a strange result as the ultimate payment was, in a general accounting sense, related to the earlier business. The applicant argued ``for a common sense result'' and suggested that the dicta in AGC could provide sufficient justification for the result it contended for.

33. I consider myself bound by all the authorities that have followed AGC and have applied De Bavay in one way or another. If there is to be a different perception of the law, then higher authority than this Tribunal will be required to determine it. As I see it, however, a re-examination of AGC does not, in any event, lead to a result that would be favourable to the applicant.

34. The decision under review is affirmed.